INVESTOR EDUCATION

Background Information

What are CISs or unit trusts?

Unit trusts are a type of Collective Investment Scheme (CIS) in which a group of investors pool their money in order to have it managed by a professional investment manager. The investors share in the risks and benefits of the unit trust in proportion to their participatory interest.

How are CISs classified?

CISs are classified to allow investors to compare and contrast investment risk and returns of similar funds.

They are classified based on where they invest – the geographic region which could be South Africa or offshore or a combination; and based on what they invest in – equities, bonds, money market securities, listed real estate or a combination.

What are hedge funds?

Hedge funds in a developed market typically refer to pooled investment vehicles that are less regulated than their unit trust-type counterparts. These lower regulatory levels allow hedge fund managers to utilise sometimes complex investment strategies and also make use of leverage and derivative instruments.

Within South Africa, hedge funds have historically been licensed and regulated by the FSB but have not fallen into CIS-type regulation like unit trusts. New initiatives will see South African hedge funds become part of the CIS environment and two types of hedge funds will be available to investors, namely restricted hedge funds and retail hedge funds.

Restricted hedge funds will only be available for qualified investors whereas the more closely regulated retail hedge funds will cater for a broader investing market.

Are hedge funds risky?

Although “hedge fund” is a blanket term applied to all alternative investments, not all hedge funds are the same. Different hedge fund managers will adopt different investment strategies and make use of different instruments in an effort to generate investment performance.

These different investment “styles” lead to different risk profiles. Some hedge fund styles are less risky than a typical CIS while others are decidedly riskier.

Starting to Invest

What are asset classes?

There are many different financial instruments that investors can choose to buy or sell, these instruments are grouped together into what are known as “asset classes”. Typically, the asset classes available to investors are:

Equities

Bonds or Fixed Income

Cash

Property or Real Estate

Commodities

Hedge Funds or Alternatives

Each asset class has broad risk and return characteristics, however, within each asset class, there are multiple sub-categories. For instance, within equities, we can further classify by:

Region e.g. Emerging market equities versus developed market equities

Country e.g. United States equities versus Brazilian equities

Industry e.g. Biotech equities versus utility company equities

Size (Market Capitalisation) e.g. Large cap versus small cap

Asset classes do not tend to move in lock-step with each other, they tend to be uncorrelated during normal market conditions. This is also true within asset classes – different regions or industries within equities markets offer different performance at different times.

Which asset class should I choose?

At Blue Quadrant Capital Management we believe that equities as an asset class will, over long periods of time, outperform any other asset class. As such, investing in equities should be the first consideration of an investor wishing to build capital.

DIY or not?

DIY investing has become easier, certainly within a South African context. Many banks now offer the ability to trade in South African equities direct from a savings account and there are various online trading platforms.

Typically, investors have made use of a financial advisor to plan and facilitate investments. Financial advisors do have an important role to play for many investors particularly in helping investors put a sound financial plan in place.

Financial advisors tend to steer investors towards CIS investment products and will often select a basket of unit trusts. For undertaking the planning work and facilitating the investments, financial advisors will earn a fee for their time or a commission from the unit trust providers.

While there are in fact more unit trusts in South Africa than equities, there is often no reason why investors can’t select an appropriate basket of unit trusts themselves.

By investing in a unit trust, the decision on which underlying instruments to buy is outsourced to the investment manager. Importantly, an investment manager not only selects the underlying investments but also decides on how much to allocate to each investment in order to construct a portfolio with an appropriate overall risk profile.

How much should I invest?

It largely depends on your current income level and your age. Ideally, a person would want to save as much as possible from their monthly income, although as a rule of thumb a target of 15% (of monthly income) is a useful guideline. But your age or years to retirement are also important considerations.

Although equities as an asset class are likely to outperform any other asset class over a long period of time, the returns that equities generate over any shorter time frame (such as one year) is highly volatile. In order for any investor to ensure that he captures the excess returns equities as an asset class may offer, he needs to have a minimum investment horizon of at least five years.

If you are at or near retirement or in a position where you will need to draw on your savings than it is prudent to shift some of your savings more towards income-related asset classes such as money market funds or bonds. The exact proportion you should shift to income-related asset classes depends very much on the quantum of savings or capital you have accumulated relative to your income (or expense) requirements and also ultimately life expectancy.

When should I start to invest?

There is no “best time” to invest in the equity market, as timing the market or an exact “peak” or “bottom” in the market is impossible. Even for the most experienced investment professionals.

It is also our view that the best way for any investor to build capital is to continuously invest some savings in a regular periodic fashion, i.e. monthly. This means that as an investor, you effectively “average in” over time and even if equity markets decline for a period of time, by continuing to invest through the cycle you will be able to take advantage of those lower prices.

For instance, our research has shown that even if you had started investing in the US equity market in 1929, ahead of the worst bear market in US history (the US equity market declined by 90% between 1929 and 1933), as long as you were able to continuously invest into the equity market by making regular monthly contributions, you would have generated a cumulative positive return on your portfolio by the end of 1935 or 6 years after starting to invest despite investing into a bear market.

Blue Quadrant’s Services

Can you assist me with a financial plan?

Blue Quadrant Capital Management does not provide financial planning services. Our core competency is the management of investment capital on behalf of our clients. We are very happy to recommend a financial advisor

We do work with a network of accredited financial planners and wealth managers and would be very happy to provide you with a recommendation.

What products do you provide?

Both funds are equity focused and as such are appropriate investment vehicles for investors with a time horizon of five years or longer. They would form good building blocks for a longer-term capital accumulation strategy, either for younger investors or for those wishing to bequeath their investment wealth.

Should I place all my investments with Blue Quadrant?

Not necessarily!

In our opinion, the best option for an investor is select 2 or 3 well managed active equity funds and allocate equally on a regular basis to all of them. An investor could even choose to allocate some of his savings to an equity index ETF, which are typically low cost and tend to outperform 60% to 70% of all actively managed equity funds.

However, in selecting different equity funds or fund managers, we believe it is important to ensure that they have different investment styles or even mandates. This will ensure a level of diversification in your portfolio, which should over time add to your overall returns.

Investment Styles

What are investment styles?

The job of any investment manager to generate either income or capital appreciation or both over time. The manner in which the investment manager goes about selecting instruments to include in the investment portfolio depends on the investing style or process or philosophy being followed.

Ideally as an investor, you would want to include managers following different styles within an investment portfolio as different investment styles require different market and economic conditions in order to perform best.

Value versus growth

As Blue Quadrant is a predominantly equity-focused manager, we will focus on styles of equity investing. Within equity investment, the two most popular styles of investing are value and growth.

When a manager follows a growth strategy, typically the companies they select to invest in are in a growth phase, often much-loved by “the market” and typically engaging in a new and exciting industry. As they are popular stocks, the purchase price can be high. It can mean buying expensive in the hope it becomes even more expensive.

When a manager is more value orientated, they are essentially looking for companies that are cheap, but where the manager believes there is a significant opportunity for the price of the company to “re-rate”. Value companies are those in which “the market” has not yet recognised their potential. The flaw with a lot of value investing, is that there can be a lack of catalyst to unlock the value – some trigger that brings about the re-rating. This phenomena is known as the “value trap”. A cheap company simply stays cheap.

Top-down and bottom-up

Top-down and bottom-up are often used terms to describe an investment process. A top-down process means that the manager starts, or places more emphasis on an analysis of the broad economy and industry or market environment. They would look for geographies, sectors or industries which look compelling from an invstment perspective.

A bottom-up manager places far more emphasis on understanding specific companies. They will assess the financial position of the company and generate expectations for future growth of that company. On a company-by-company basis, investment decisions will be taken.

At Blue Quadrant, we use something of a hybrid model. While we look for companies which look compelling as stand-alone investments, we believe assessing the economic and industry environment in which the company operates is vital. These factors – economic, industry and company – need to be aligned to ensure the value trap is avoided and there is indeed a catalyst to unlock the value of the investment.